You have S1,000 that you can invest. If you buy Ford stock, you face the followi

Question

You have S1,000 that you can invest. If you buy Ford stock, you face the following returns and probabilities from holding the stock for one year: with a probability of 0.2 you will get S1,500; with a probability of 0.4 you will get $1,100; and with a probability of 0.4 you will get $900. If you put the money into the bank, in one year's time you will get $1,100 for certain. a. What is the expected value of your earnings from investing in Ford stock? b. Suppose you are risk-averse. Can we say for sure whether you will invest in Ford stock or put your money into the bank?

Explanation / Answer

a. expected value of earnings from investing in ford stock is $1,100 as shown below.

b. A risk averse investor will put money into bank, since there is a degree of uncertainity attached with stock investments.

On the other hand, it is certain to receive $1,100 from investment in bank.

Probability amount Probability* amount 0.2 $1,500 ($1500*0.2)=>$300 0.4 $1,100 ($1,100*0.4)=>$440 0.4 $900 ($900*0.4)=>$360 expected value or earnings $1,100

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